Pennsylvania made important changes to its LLC law effective in 2017. John H. Prorok, partner with Maiello, Brungo & Maiello, LLP, explains the key provisions.
On February 21, 2017, Act 2016-170 (15 Pa. C.S. § 8811 et seq.) went into effect and significantly revised Pennsylvania law on partnerships and limited liability companies (LLCs). The Act amended Title 15 (Corporations and Unincorporated Associations) and Title 54 (Names). Since LLCs are among the most popular corporate form, business owners and those contemplating starting a business should take note of the changes in the law related to LLCs. The Act took effect in 2-stages: on February 21, 2017 for all entities that are formed on that date or afterwards; and April 1, 2017 for all entities formed before February 21, 2017.
Elimination of Apparent Statutory Authority
One of the key provisions of the Act is the elimination of the “apparent statutory authority” of members of an LLC. Under the prior law, a member, simply by virtue of being a member, was considered an “agent” of the LLC. Under that apparent authority, the member could ordinarily bind the LLC. Now, a member expressly lacks that apparent statutory authority under the Act. The LLC may file a certificate of authority setting forth the “authority, or limitations on the authority” of either (i) a specific person or (ii) a person holding a certain position within the LLC, to enter transactions, to transfer real property held by the LLC, and otherwise bind the LLC.
Transfer of real property
With respect to the transfer of real property, the certificate of authority, when recorded with the recorder of deeds for the county in which the property is located, will be conclusive in favor of the person who gives value in reliance on the authority granted in the recorded certificate. (15 Pa. C.S. §8832(f).) Members and Managers of LLCs should expect title insurance companies to require the recording of a certified certificate of authority in any transaction for the sale or purchase of real property in the name of the LLC.
Another major change from the prior law is that the Certificate of Organization, which is filed with the Department of State, is no longer required to state whether the LLC is member-managed or manager-managed. In a shift to having the operating agreement assume greater importance in governing the LLC, the Act now allows the operating agreement to establish the status of a member-managed or manager-managed LLC. An operating agreement is not filed with the Department of State and thus the public will not know from the public record if an LLC is member-managed or manager-managed. Those transacting business with an LLC should perform due diligence and obtain a certificate of authority.
Duty of loyalty and duty of care
The Act also allows the LLC and its members to modify some aspects of the duty of loyalty and duty of care in the operating agreement, but the agreement may not eliminate the duties altogether. Members may now specify in the operating agreement types of actions and transactions that do not violate the duties, if the conduct and transactions are not “manifestly unreasonable.” (15 Pa. C.S. § 8815(e).) Under this standard, the following duties of loyalty may be altered by the operating agreement:
- the duty of a member to account to the LLC and to hold as trustee for it any property, profit or benefit derived by the member in the conduct of or winding up of the LLC’s activities and affairs;
- the duty of a member to account to the LLC and to hold as trustee for it any property, profit or benefit derived by the member from a use by a member of the LLC’s property; and
- the duty of a member to refrain from dealing with the LLC in the conduct or winding up of the LLC’s activities and affairs as or on behalf of a person having an interest adverse to the LLC.
Members must pay careful attention to the operating agreement because, as the Pennsylvania Committee stated in its Comments to the Act, the operating agreement can reduce the duty of care almost to nil, and, in particular, the operating agreement can eliminate the aspects of the duty of care pertaining to gross negligence.
Transfer of right of distributions
The Act allows a transfer of any right of distributions that a member of the LLC has under the operating agreement. (15 Pa. C.S. § 8852.) The members can elect to impose restrictions on a right to transfer by stating such restrictions in the LLC’s operating agreement. Absent a contrary provision in the operating agreement or the consent of the members, a “transferable interest” is the only interest in a limited liability company that can be transferred to a non-member. The transferable interest is the member’s right to receive any distributions from the LLC. Under the Act, a transferee of the transferable interest is not entitled to participate in the management of the LLC or have access to records or other information concerning the LLC affairs and activities.
The Act provides the sole method by which a judgement creditor can execute against a member’s interest in an LLC. (15 Pa. C.S. § 8853.) The charging order would give the judgment creditor a lien on the member’s transferable interest (the right to receive any distributions from the LLC); however, the charging order does not grant the creditor any rights to manage the LLC that a member would possibly have. If the charging order does not satisfy the creditor’s judgment in full, the creditor may foreclose on the member’s interest. As with the charging order, the purchaser in foreclosure would only acquire the transferable interest, and would not be considered a member of the LLC.
Previously, LLCs in Pennsylvania could not be a not-for-profit company. Persons wishing to create a not-for-profit enterprise were limited to a not-for-profit corporation. The Act expands the permissible purposes of an LLC to not-for-profit purposes. The exact not-for-profit purpose must be defined in the LLC’s Certificate of Organization. A nonprofit LLC is permitted to receive and hold real property in trust for the purposes set forth in its Certificate of Organization. A not-for-profit may want to create and own an LLC to protect itself from risks and liabilities associated with its activities or to operate a business that is not substantially related to advancing its exempt purpose.
In addition to not-for-profit LLCs, the Act created “Benefit Companies” or a “Benefit LLC”. A Benefit Company is an entity whose purpose must be for the general public benefit (and may be for a specific public benefit) meaning that it must have a “material positive impact on society and the environment, taken as a whole and assessed against a third-party standard, from the business and operations of a benefit company”. The third-party standard must be maintained by the Benefit LLC and any reports and assessments confirming the third-party standard must be made publicly available. Thus, Benefit LLCs will be more transparent than other entities.
Conclusion – check your operating agreement
These are a few of the key changes to Pennsylvania’s law governing LLCs. Members in existing LLCs need to review their current operating agreements to determine if they are now bound by the default rules in the Act which govern the relationships among members. It may be prudent to revise the operating agreement now that the Act’s provisions apply to all existing LLCs. Persons considering creating an LLC for a new business must also pay attention to any proposed operating agreement prior to adopting it so that they do not find themselves investing in an LLC that may not reflect how they wish to operate or treat each other.